The History Of Banking Essay Research Paper

The History Of Banking Essay, Research Paper

A common definition of a bank is a financial intermediary that accepts, transfers, and, most important, creates deposits. This includes such depository institutions as central banks, commercial banks, savings and loan associations, and mutual savings banks.

Banks are most frequently organized in corporate form and are owned either by private individuals, governments, or a combination of private and government interests. Although noncorporate banks-that is, single proprietorships and partnerships-are found in other countries, since 1863 all federally chartered banks in the United States must be corporations. Only a few states permit formation of noncorporate banks. All countries subject their banks, however owned, to government regulation and supervision, normally implemented by central banking authorities.

Early Banking

Many banking functions such as safeguarding funds, lending, guaranteeing loans, and exchanging money can be traced to the early days of recorded history. In medieval times, the Knights Templars, a military and religious order, not only stored valuables and granted loans but also arranged for the transfer of funds from one country to another. The great banking families of the Renaissance, such as the Medicis in Florence (Italy), were involved in lending money and financing international trade. The first modern banks were established in the 17th century, notably the Riksbank in Sweden (1656) and the Bank of England (1694).

Seventeenth-century English goldsmiths provided the model for contemporary banking. Gold stored with these artisans for safekeeping was expected to be returned to the owners on demand. The goldsmiths soon discovered that the amount of gold actually removed by owners was only a fraction of the total stored. Thus, they could temporarily lend out some of this gold to others, obtaining a promissory note for principal and interest. In time, paper certificates redeemable in gold coin were circulated instead of gold. Consequently, the total value of these banknotes in circulation exceeded the value of the gold that was exchangeable for the notes.

Two characteristics of this fractional-reserve banking remain the basis for present-day operations. First, the banking system’s monetary liabilities exceed its reserves. This feature was responsible in part for Western industrialization, and it still remains important for economic expansion. The excessive creation of money, however, may lead to inflation. Second, liabilities of the banks (deposits and borrowed money) are more liquid-that is, more readily convertible to cash-than are the assets (loans and investments) included on the banks’ balance sheets. This characteristic enables consumers, businesses, and governments to finance activities that otherwise would be deferred or cancelled; however, it underlies banking’s recurrent liquidity crises. When too many depositors request payment, the banking system is unable to respond because it lacks sufficient liquidity. The lack of liquidity means that banks must either abandon their promises to pay depositors or pay depositors until the bank runs out of money and fails. The advent of deposit insurance in the United States in 1935 did much to alleviate the fear of deposit losses due to bank failure and has been primarily responsible for the virtual absence of runs on U.S. banks.

Commercial Banking in the U.S.

Commercial banks are the most significant of the financial intermediaries, accounting for some 60 percent of the nation’s deposits and loans. The first bank to be chartered by the new federal government was the Bank of the United States, established in Philadelphia in 1791. By 1805 it had eight branches and served as the government’s banker as well as the recipient of private and business deposits. The bank was authorized to issue as legal tender banknotes exchangeable for gold. Although the bank succeeded in establishing a sound national currency, its charter was not renewed in 1811 for political and economic reasons. The history of the second Bank of the United States (1816-36) repeated that of its predecessor. It served ably as the government’s banker, achieved a sound national currency, and failed for political reasons when President Andrew Jackson vetoed charter renewal.

In the next three decades the number of banks grew rapidly in response to the flourishing economy and to the system of “free banking”-that is, the granting of a bank charter to any group that fulfilled stated statutory conditions. Government fiscal operations were handled initially by private bankers and later (after 1846) by the Independent Treasury System, a network of government collecting and disbursing offices. The Independent Treasury, however, could not cope with the financial demands of the American Civil War. Moreover, the multiplicity of state banks, each issuing its own banknotes, had resulted in a highly inefficient currency mechanism. The National Bank Act (1864) established the office of the comptroller of the currency to charter national banks that could issue national banknotes (this authority was not revoked until 1932). A uniform currency was achieved only after a tax on nonnational banknotes (1865) made their issuance unprofitable for the state-chartered banks. State banks survived by expanding their deposit-transfer function, continuing to this day a u